The International Monetary Fund dropped a long-held view that the yuan was undervalued, contradicting the U.S. assessment and strengthening China’s case for the currency to win reserve status at the lender in a coming review.
“Appreciation over the past year has brought the exchange rate to a level that is no longer undervalued,” the IMF’s mission to China said in a statement Tuesday. “China should aim to achieve an effectively floating exchange rate within two to three years.”
The yuan rose against all 31 major currencies over the past 12 months, while Russia’s ruble and Brazil’s real were the biggest losers. The exchange rate’s resilience as the U.S. prepares to raise interest rates boosts the attraction of holding yuan, helping increase worldwide usage before the IMF reviews its Special Drawing Rights basket of reserve currencies in late 2015. China is promoting the yuan as an alternative to the dollar, which dominates global trade and finance.
“The IMF remarks signal that the yuan has matured to a stage that it could be held as a reserve currency,” said Banny Lam, co-head of research at Agricultural Bank of China International Securities Co. in Hong Kong. “Even if the yuan becomes a reserve currency, it won’t threaten the dollar in global trade as it will take much more time for yuan to be adopted widely.”
The yuan still has some way to go before it can become a major reserve currency, former Federal Reserve Chairman Ben S. Bernanke said Tuesday in Taipei. The IMF requires that a currency is “freely usable” to be included in its SDR basket.
Endorsement by the Washington-based lender would lead to about $1 trillion being switched into Chinese assets over the next five years, according to an estimate this month from Standard Chartered Plc. AXA Investment Managers estimated some 10 percent of the $11.6 trillion of global reserves would flow into yuan assets, though it didn’t give a timeframe.
China should allow greater flexibility in its exchange rate, with intervention limited to avoiding disorderly market conditions or excessive volatility, said the IMF’s China mission, which is led by the lender’s deputy director of Asia and Pacific Markus Rodlauer. The statement said it contains the views of the IMF staff involved and has not yet been endorsed by the institution’s board.
The yuan rose 0.6 percent versus the dollar in the past 12 months, while Brazil’s currency dropped 28 percent and Russia’s slid 32 percent. China’s productivity will probably rise more rapidly than the rest of world so its exchange rate will need to appreciate to take account of that, David Lipton, the IMF’s No. 2 official, said at a briefing Tuesday in Beijing.
A few hours later, the U.S. Treasury Department reiterated its view that the yuan remains significantly undervalued. The world’s second-largest economy needs to implement planned financial-policy changes for the yuan to qualify for inclusion in the SDR basket, according to a Treasury official who briefed reporters by phone Tuesday on condition of not being identified.
The IMF will work closely with the Chinese authorities on adding the yuan to the SDR basket, the IMF’s Rodlauer said. The inclusion is not a matter of “if” but “when,” he said. The SDR basket is reviewed every five years and currently comprises the dollar, euro, yen and British pound.
The assessment that the yuan is no longer undervalued “is already a market consensus view, and two-way fluctuations of the exchange rate have become normal,” said Yao Wei, a Paris-based China economist at Societe Generale SA. “The IMF comment has a greater political importance than on the market.”